8 smart tax moves to make before the end of the year

These are especially important to do if the Republican tax changes go through for next year

Joe Raedle/Getty Images

By

BillBischoff

It’s time to think about making some moves to lower your personal 2017 federal income tax bill while also positioning yourself for tax savings in future years. The X Factor is whether a GOP-sponsored tax reform package will be enacted. Even if that happens before year-end, it won’t take effect until next year. So your 2017 federal income return will be filed under the current rules. With those thoughts in mind, here’s part 2 of our list of the best year-end moves to consider with tax reform in the air. For part 1, see Here are the best ways to reduce your tax bill this year.

Strategy: Prepay deductible expenditures (now more than ever)

If you itemize deductions, accelerating deductible expenditures into this year to produce higher 2017 write-offs makes sense if you expect to be in the same or lower tax bracket next year. If you turn out to be in a lower bracket next year (more likely if tax reform happens — see the table below), deductions claimed this year will be worth more than the same deductions claimed next year. Also, as explained a bit later, tax reform might eliminate or cut back some itemized deductions starting with next year. So that’s an additional reason to prepay some deductible expenses before year-end, while the current more-favorable itemized deduction rules still apply.

January house payment: Accelerating the house payment that is due in January will give you 13 month’s worth of deductible interest in 2017 (unless you’ve already been following the prepayment drill, in which case you need to keep it up to have 12 month’s worth of interest deductions for this year’s return). You can use the same strategy with a vacation home.

State and local taxes: Prepaying state and local income and property taxes that are due early next year can reduce your 2017 federal income tax bill, because your total itemized deductions will be that much higher.

Medical expenses and miscellaneous deduction items: Consider prepaying expenses that are subject to deduction limits based on your adjusted gross income (AGI). AGI is the number at the bottom of page 1 of your Form 1040. It includes all taxable income items and a few write-offs such as the ones for alimony paid and moving expenses. The two prime AGI-sensitive candidates for the prepayment strategy are medical expenses and miscellaneous itemized deductions.

Under current law, medical expenses are deductible only to the extent they exceed 10% of AGI. So loading up on elective procedures, dental care, glasses, and contacts before year-end could get you over the 10%-of-AGI hurdle and result in a meaningful medical expense deduction.

Miscellaneous deductions — for investment expenses, job-hunting expenses, fees for tax preparation and advice, and unreimbursed employee business expenses — count only to the extent they exceed 2% of AGI. If you can bunch these kinds of expenditures into a single calendar year, you’ll have a fighting chance of clearing the 2%-of-AGI hurdle and getting some tax savings.

Warning: Prepaying is not a no-brainer: The prepayment strategy can backfire if you will owe the alternative minimum tax (AMT) for this year. That’s because write-offs for state and local taxes are completely disallowed under the AMT rules and so are most miscellaneous itemized deductions. So prepaying these expenses may do little or no tax-saving good for AMT victims. Solution: ask your tax adviser if you’re in the AMT mode before prepaying state and local taxes or miscellaneous deduction items. The good news: both the House and Senate tax reform bills would eliminate the AMT for 2018 and beyond. Fingers crossed!

Possible tax reform: For 2018 and beyond, the House GOP tax reform bill would eliminate itemized deductions except those for home mortgage interest (subject to a lower debt limit for new loans and deductions for only one residence), charitable contributions, and state and local property taxes (subject to a $10,000 limit, or $5,000 for those who use married filing separate filing status). Foreign real property taxes would be nondeductible. State and local income taxes would be nondeductible.

The Senate GOP tax reform bill would eliminate itemized deductions except those for home mortgage interest (with no deduction allowed for home-equity loans), charitable contributions, medical expenses, and personal casualty losses in federally declared disaster areas. Deductions for state and local income and property taxes and foreign property taxes would be completely eliminated.

Under the House bill, for principal residence mortgage loans taken out after Nov. 2, 2017, you could only deduct interest on up to $500,000 of mortgage debt (versus up to $1 million plus another $100,000 of home equity debt allowed under the current rules). The current-law provision that allows you to deduct interest on up to $100,000 of home equity debt would be eliminated. However, if you refinance a loan taken out before Nov. 3, 2017, the higher loan limits allowed under the current rules would continue to apply. Finally, starting next year, you could only deduct mortgage interest on one qualified residence under the House bill (versus two homes under the current rules). So no more deductions for mortgage interest on both your main residence and a vacation home under the House bill. Under the Senate bill, you could still deduct interest on up to $1 million of mortgage debt for up to two homes, but the current-law provision that allows you to deduct interest on up to $100,000 of home equity debt would be eliminated.

For 2018 and beyond, both the House and Senate bills would eliminate itemized deductions for tax preparation fees, unreimbursed employee business expenses, and most other miscellaneous itemized deduction items.

Key point: Under both the House and Senate bill, increased standard deduction amounts would offset some or all of the deductions lost to tax reform, depending on your specific circumstances. In any case, prepaying deductible items before year-end will help lower this year’s tax bill (subject to the Warning for AMT victims).

Strategy: Deduct state and local sales taxes instead of income taxes

If you will owe little or nothing for state and local income taxes in 2017, you can choose to instead deduct state and local general sales taxes. You can deduct a predetermined sales tax amount from an IRS table based where you live and other factors — unless you’ve kept receipts that support a bigger deduction. In addition to the table amount, you can deduct actual sales tax amounts for major purchases such as a motor vehicle (car, truck, SUV, van, motorcycle, off-road vehicle, motor home, or recreational vehicle), a boat, an airplane, a home (including a mobile prefabricated home), or a substantial addition to or major renovation of a home. You can also include actual state and local general sales taxes paid for a leased motor vehicle. So making a major purchase or vehicle lease between now and year-end could give you a bigger sales tax deduction and cut this year’s federal income tax bill.

Possible tax reform: Both the House and Senate tax reform bills would eliminate this option for 2018 and beyond, so use it this year or maybe lose it.

Strategy: Prepay college tuition

If your 2017 AGI allows you to qualify for the American Opportunity higher-education tax credit (worth up to $2,500 per qualifying undergraduate student) or the Lifetime Learning higher-education tax credit (worth up to $2,000 per tax return and covering most postsecondary education expenses including graduate school), consider prepaying college tuition bills that are due in early 2018 if that would result in a bigger credit on this year’s Form 1040. Specifically, you can claim a 2017 credit for prepaying tuition for academic periods that begin in January through March of next year.

The American Opportunity credit is phased out (reduced or completely eliminated) if your modified AGI (MAGI) is too high. The phaseout range for unmarried individuals is between MAGI of $80,000 and $90,000. The range for married joint filers is between $160,000 and $180,000. MAGI means “regular” AGI, from the last line on page 1 of your Form 1040, increased by certain tax-exempt income from outside the U.S. which you probably don’t have.

Like the American Opportunity credit, the Lifetime Learning credit is also phased out if your MAGI is too high. However, the Lifetime Learning credit phaseout ranges are much lower, which means they are much more likely to affect you. The 2017 phaseout range for unmarried individuals is between MAGI of $56,000 and $66,000; the phaseout range for married joint filers is between $112,000 and $132,000.

Possible tax reform: The Senate tax reform bill would leave both credits in place under the existing rules. The House bill would eliminate the Lifetime Learning credit for 2018 and beyond and liberalize while the American Opportunity credit to cover the first five years of undergraduate education (versus only four years under the current rules). If the Lifetime Learning credit goes away, there will be no credit for graduate school or other postsecondary education beyond the first five years of undergraduate study. So use the Lifetime Credit this year or maybe lose it.

Strategy: Accelerate adoption expenses

Under current law the tax credit for qualified adoption expenses can be up to $13,570 for 2017. An employer adoption assistance plan can cover up to that amount for you federal-income-tax-free. The Senate bill would retain these breaks, but the House bill would eliminate them for 2018 and beyond. So consider accelerating qualified expenditures into this year if that would deliver a bigger 2017 break.

Strategy: Buy plug-in electric vehicle this year

Under current law, you can claim a credit of up to $7,500 for buying a new plug-in electric vehicle in 2017. See You can get a $7,500 tax credit for a new electric vehicle. The Senate bill would retain this break, but the House bill would eliminate it for 2018 and beyond. So take advantage of the credit this year or maybe lose it.

Strategy: Accelerate charitable giving

Prepaying charitable donations that you would otherwise make next year can reduce your 2017 federal income tax bill, because your total itemized deductions will be that much higher. Charitable deductions claimed this year will be worth more than deductions claimed next year if your tax rate goes down next year (more likely for many folks with tax reform in the air). Donations charged to credit cards before year-end will count as 2017 contributions, even though you won’t pay the credit card bills until early next year.

If you have appreciated stock or mutual fund shares (currently worth more than you paid for them) that you’ve held in a taxable brokerage firm account for over a year, consider donating them, instead of cash, to IRS-approved charities. You can generally claim an itemized charitable deduction for the full market value at the time of the donation and avoid any capital-gains tax hit. On the other hand, don’t donate loser stocks. Sell them, book the resulting tax-saving capital loss, and donate the cash sales proceeds.

Strategy: Make charitable donations from your IRA

You can make up to $100,000 in cash donations to IRS-approved charities directly out of your IRA if you will be age 70½ or older as of year-end. Such direct-from-your-IRA donations are called qualified charitable distributions, or QCDs. They are tax-free and no deductions are allowed for them, so QCDs don’t directly affect your tax bill. However, they count as withdrawals for purposes of meeting the required minimum distribution (RMD) rules that apply to your traditional IRAs after age 70½. So if you have not yet taken your 2017 RMDs, you can arrange to take tax-free QCDs before year-end in place of taxable RMDs. That way you can meet your 2017 RMD obligations in a tax-free manner while satisfying your charitable impulses at the same time. For details on the RMD rules, see Understanding the IRA mandatory withdrawal rules.

The last word

At this point, nobody knows for sure whether major tax changes will be enacted this year and take effect next year. But the strategies suggested here should work regardless. Meanwhile stay tuned for further developments and be prepared to make some additional quick moves near year-end — if necessary.

2017 individual federal income tax brackets

Single

Joint

Head of household

10% tax bracket

$ 0-$9,325

$0-$18,650

$0-$13,350

Beginning of 15% bracket

9,326

18,651

13,351

Beginning of 25% bracket

37,951

75,901

50,801

Beginning of 28% bracket

91,901

153,101

131,201

Beginning of 33% bracket

191,651

233,351

212,501

Beginning of 35% bracket

416,701

416,701

416,701

Beginning of 39.6% bracket

418,401

470,701

444,551

2018 individual brackets under House GOP tax reform bill

For 2018 and beyond, the House GOP bill would reduce the number of individual tax rates from the current seven to four: 12%, 25%, 35%, and 39.6%. The last rate is the same as the highest rate under current law. The proposed rate brackets are as follows, based on taxable income (gross income minus allowable write-offs).

Single

Joint

Head of household

12% tax bracket

$ 0-$44,999

$0-$89,999

$0-$67,499

Beginning of 25% bracket

45,000

90,000

65,000

Beginning of 35% bracket

200,000

260,000

200,000

Beginning of 39.6% bracket

500,000

1,000,000

500,000

2018 individual brackets under Senate GOP tax reform bill

For 2018 through 2024, the Senate GOP bill would keep seven tax brackets, but most rates would be reduced as follows. In 2025, the current-law rates and brackets would come back. The proposed temporary rate brackets are as follows.

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